The end of the year is high season for charitable donations — and with investment firms assuming a leading role in philanthropic giving, they face red flags and challenges. Compliance risk is rising for wealth managers trying to match the philanthropic clout of Fidelity, Vanguard, Goldman Sachs and others that have created charitable funds.

The vehicle of choice is the donor-advised funds that have boomed in recent years by offering investors a simplified one-step vehicle for tax-advantaged philanthropy. Some investment professionals have run into problems by assuming that a lack of rules hard rules for giving away money makes it easy: Specialists, however, warn that philanthropic giving is a complex venture that poses risks for investment professionals crafting their own tax-advantaged vehicles for clients.

Securities regulators have taken an increasing number of disciplinary actions against a more than a dozen investment professionals over the past year in an enforcement arena that had largely been the domain of state regulators and the Internal Revenue Service.

Hundreds of thousands of accounts

Enforcement cases have ranged from violations of marketing and sales practice rules of the Financial Industry Regulatory Authority to a Securities and Exchange Commission $9 million investment adviser’s fund diversion scheme last December using a charitable foundation as as vehicles for fraud.

Compliance teams at brokerage firms and investment advisories are seeing a flood of new clients seeking advice on philanthropies and private foundations. With 10,000 Americans reaching age 65 each day, new controls will be needed as clients shift gears from accumulating assets to managing and passing on wealth. Investment firms are looking for ways to remain relevant as trillions of dollars in assets hit the transition point.

“There is a large group of financial advisers who have begun to feel their business is a commodity, and to solve for the commoditization they feel a need to become more involved in ancillary issues,” said John O. McManus, attorney for the estate planning law firm, McManus & Associates. “We see a lot of mistakes and mismanagement and firms needing help fixing issues.”

“Mass affluent” become most philanthropic

Problems arise when investment professionals overstep their expertise in offering services that involve far more complex legal and accounting requirements than transactions and retirement planning. Some are misled by the fact philanthropic ventures are relatively free of regulatory oversight. But there is deceptive complexity in managing charitable activities for clients, and increasing scrutiny on investment and advisory professionals dealing with senior investors making difficult choices.

Setting up private foundations has been the routine for high net-worth individuals with the money to hire professionals in accounting, law and finance. The industry is being hit with a growing wave of middle-income or “mass affluent” who are increasing their giving while wealthier, tax-conscious individuals have slowed their charitable contributions, which have been made less attractive by tax cuts and revisions.

“Fuse is lit” at end of year

The end of the year brings the scramble for clients and firms to decide contributions. The “fuse is lit at the end of the year,” as they race against a deadline to put funds to work to take advantage of tax breaks for the next year’s taxes. The initial setup work for a private foundation may be relatively simple and quick, but follow-up reporting can place an continuing burden that can be onerous for firms and perilous for clients. Privately-funded charities, for example, must report every transaction separately, unlike retirement accounts. Private foundations require board meetings and minutes carefully documented.

“There are ever-changing laws and operations need to be updated to meet them,” said Tamara Surratt, president and chief executive officer of Legacy Family Office. “People think that there are all kinds of rules on who you can give to. It’s true, you have to be careful about giving to a apolitical organization or campaign, or for anything that gives you a personal benefit. But that is not the biggest concern.”

The boom in donor-advised funds offered by most large brokers and fund companies has provided a way for individuals to avoid the complication and cost of a private foundation, and hundreds of thousands have used the alternative. Fidelity’s donor fund has become the largest charitable foundation, surpassing United Way two years ago. The assets of the donor advised funds are expected to top $100 million this year after quadrupling over the past five years.

Funds get “gift that keeps on giving”

The funds themselves have found a comfortable niche, although the philanthropic community has viewed them anxiously and criticized the fund sponsors for being lured by “the gift that keeps on giving” — since firms collect fees on funds they can hold and manage for years without any requirement to give them to away. They are not bound, as non-profit foundations are, to put 5 percent of their assets into the hands of beneficiaries. They have on average paid out about 20 percent, but there is no legal obligation to do so.

“The donor advised funds are really offering a service to their clients. The fees are low, and it’s not a big profit center for them. It’s a perfect choice for smaller charitable contributions, ” said McManus, although individuals with over $500,000 to contribute to tax-advantaged charities can justify the accounting and legal professionals costs required of a private foundation.

“I would hope the UBSs and Merrill Lynchs of the world would educate their advisers on the pitfalls that could befall managing a foundation,” said Surratt. “It should be flagged and there should be resources allocated to that individual. There are a whole host of things to be considered. The average investment professional is schooled in managing investments, or gathering assets. Not running a private foundation.”

Single missed payment

Wealth managers often look for ways to partner with accountants and law firms to manage the wealthy client who sets up private funds. The agreements are ripe for problems if the reporting responsibilities are not made clear from the start, said McManus. A single missed disclosure or missed payment can jeopardize the foundation’s status, he added. But the private fund route allows the wealth manager and client more control over the process and allows for “an enduring charity, with a family ethos, with participation that keeps families together.”

The donor advised funds give control to the firm managing the account and take care of compliance issues on the fund level, providing a practical way for small investors to do tax-advantaged contributions. Charitable gift annuities are another way that small investors can make donations directly to a qualified charity. Tax law changes have made possible qualified charitable distributions from individual retirement accounts, which are a simple way to covert required minimum distributions into a tax-advantaged contribution without itemizing deductions.

The increasing popularity of such investments will place demands on compliance to make certain clients interests are being served at a time when retail protection of seniors is a top priority for securities regulators.

Firms need conversation with clients

“It is one of the biggest issues facing the industry and it is important to understand the implications of the huge wealth transfer coming over the next 10 to 20 years,” said Surratt. ”It’s incumbent on advisers to be thoughtful and think of what is the best interest of clients and to think long term about what legacy they wish to leave.”

Firms need to make certain that brokers are having conversations with clients to make certain the right choices are being made and that they understand the complex transactions involved.

“These are really important conversations to have,” said Surratt “It will be difficult at firms where brokers are managing large books of clients, but it is absolutely those are really important conversations on a regular basis and for firms’ leadership to set the culture to make it possible.”

Before we know it, the calendar will turn to 2019. Today, McManus & Associates Founding Principal John O. McManus held a conference call with clients to impart insight on year-end tax strategies, in light of the new tax laws, to implement by December 31st. McManus also covered annual end-of-year essentials. Listen to a recording of the discussion by clicking below:

1. TAKE ADVANTAGE OF A LIMITED-TIME OPPORTUNITY: Since the estate tax was not repealed at the end of last year and the increased estate tax exemption is temporary, what can high-net worth families do to minimize future estate tax?

2. GET SET TO OFFSET: If you’ve already sold appreciated investments or a business in 2018 and will incur significant capital gains taxes, what can you do to enjoy a deduction and aid in offsetting the gain?

3. PLAN TO SAVE: The drastic limitation on the State and Local Tax (SALT) Deduction for Federal income tax purposes means that those who anticipate selling appreciated investments or a business in the next few years will experience unusually high capital gains taxes—but what can you do so that State capital gains taxes will not be imposed?

4. ADD TO YOUR INCOME TAX TOOLBOX: In spite of the marginal reduction of the Federal income tax rates, now that the Federal deduction on SALT has been significantly constrained, we will all have even more income tax exposure on investments. Can life insurance function as an income tax planning solution?

5. ENSURE YOU’RE UTILIZING INSURANCE: High-net worth families will continue to have State and Federal estate tax exposure, so what must remain an essential component of any well-constructed estate plan?

6. THINK OUTSIDE THE BOX: For those who have Estate Tax vulnerabilities but are elderly or in poor health, the acquisition of a life insurance policy may be uneconomical or impossible for those individuals, but how can life insurance reduce State and Federal Estate Tax while also creating wealth for future generations?

ADDITIONAL YEAR-END ESSENTIALS

THE ABCs OF ESTATE PLANNING PROTECTIONS: Regardless of tax law changes, it’s important to go back to the basics with estate planning on an annual basis. Proper year-end planning should always consider the following:

Unique challenges face us all as we grow older and become “seniors,” but with proper planning, you and your loved ones can be well-prepared to successfully navigate this stage of life.

Today, John O. McManus held an educational conference call with clients to discuss the “Top 10 Dangers and Opportunities for Seniors” – whether it’s you, your parents or your grandparents. Click below to listen to the enrichment call recording, which covers the following topics:

1. Anticipate, Before It’s Too Late: As we age, there is a significantly greater risk of incapacity. It is essential to ensure basic protections are in place so that loved ones can act immediately in the event of an emergency.

2. Spend a Little Time Planning to Save a Lot of Time Doing: The need for the Court to oversee the administration of an estate can be time-consuming, costly, and frustrating. Proper planning will allow for the probate process to be completed with greater expediency.

3. Take Advantage of the Opportunity of a Lifetime (Gift Tax Exemption): Dramatically reduce future potential federal estate tax by utilizing the temporary increase to the lifetime gift exemption.

4. Don’t Skip Over Generation-Skipping Tax: Understand the tax implications of the transfer of wealth across multiple generations to preserve your legacy for your descendants.

5. Decrease Your Chances of an Increase in Federal Income Taxes: Evaluate strategies to avoid a potential increase in federal income taxes due to limitations on state and local tax deductions.

6. Step Up Your Planning with a Step-Up in Basis: Review the power of a step-up in basis upon death, reducing capital gains tax and delivering income tax savings your loved ones can enjoy.

7. Plan for Long-Term Care in Short Order: The cost of long-term health care could drastically deplete an estate, but strategies may be available to mitigate the attrition of assets.

8. Expect the Best, Plan for the Worst: Protect the inheritance of your heirs and ensure wealth is not diverted, in case a child’s marriage fails.

9. Pay Special Attention to Special Needs: Ensure the inheritance of your children and grandchildren can be used to enhance their quality of life, while preserving their ability to receive governmental benefits.

10. Prepare Your Heirs: Aid your loved ones in the effective deployment of the wealth you pass along by imparting your family mission and values, including the intrinsic benefits of philanthropy.

Real Daily, which seeks to enrich, enlighten and empower readers to make informed choices that will positively impact their financial lives, recently published the article, “5 Reasons You Need a Self-Directed IRA.” The piece, which cites insight from McManus & Associates Founding Principal John O. McManus, begins with an overview:

· Self-directed retirement accounts, known as a self-directed individual retirement arrangement (IRA), were created in 1999 by an act of Congress after intensive lobbying of small business owners and associations.

· The beauty of a self-directed IRA is it allows you to invest up to $6,500 into a tax-deferred account where you control the investments. Many of those investments include alternative vehicles not available in a traditional IRA.

The first reason why one should consider opening a self-directed IRA is higher returns. Per the article, “The number one reason investors use self-directed IRA accounts is the ability to pursue much higher returns compared to stocks and bonds. If you make a 25% return on a real estate investment and are able to build on that profit cumulatively for 10, 30, or 30 years it can be life-changing.” The story goes on to quote McManus:

“If you understand investments, particularly in certain segments, you can take advantage of higher yields and maybe less volatility,” John O. McManus of the estate-planning firm McManus & Associates in New York and New Providence, New Jersey told NerdWallet.

McManus has invested in real estate and other assets through a self-directed IRA for about 15 years, he says.

A self-directed IRA also lets McManus invest in companies that aren’t publicly traded, which “a mutual fund will not allow you to do,” he says. But, he warns, “this is not a game for the unsophisticated.”

The following four reasons to consider a self-directed IRA include:

· Better diversification

· Investing in private equity

· Putting assets to work

· Investing in cryptocurrencies

Click here to read the full article, including more information about the five arguments in favor of a self-directed IRA, as well as the risks of self-directed IRAs.

Founding Principal of McManus & Associates John O. McManus recently spoke with Ashlea Ebeling, who writes about how to build, manage and enjoy your family’s wealth for Forbes, to share his pre and post-mortem planning advice for spouses, based on his experience working with numerous high-net-worth widows over nearly three decades. McManus also connected Ebeling with two of his clients who shared how they navigated the challenges following the passing of their partners, from managing complexities of portfolios that fell on their shoulders, negotiating with lenders and insurance carriers, how long it took before they turned a corner from a grief standpoint, and more.

The article, “A Widow’s Advice to Her Younger Self,” starts with an invaluable piece of advice: don’t let your spouse do all of your family’s financial planning without your involvement; tell him or her, “This is stuff I need to know!” Those words of wisdom came from McManus & Associates client Bridget Wilson, whose husband passed away from cancer.

From the story:

Unfortunately, the Wilsons’ case is one their estate planner, John O. McManus, says happens all too frequently. He’s helping another financially unsophisticated spouse in her 40s sort out the estate of her late husband, a real estate investor, who committed suicide. “Each one was surprised and unprepared,” he says of the widows. “They simply were not ready.”

Here are the pre-mortem key takeaways that McManus, Wilson and McManus & Associates’ other client who participated in the story hope will be helpful to others:

Do a dry run. Wilson’s husband never signed their will, “so McManus had to petition the probate judge to admit it. ‘All of that would have evaporated if the will hadn’t been validated,’ McManus says.”

And after the death of a spouse? Here are important to-do’s from the story:

Revisit your estate plan. From the article, “McManus’ first piece of advice to Wilson was to write her own will as well as a financial power of attorney and healthcare proxy. And to sign everything.”

Seek outside experts. “A good estate administrator will know his or her limits and call on experts as needed,” says Ebeling. Citing McManus’ help to the widow who lost her husband to suicide, “On behalf of the other widow, McManus hired a real estate lawyer to stop the house foreclosure, and a real estate agent to rent it out while she downsized. He introduced her to a financial advisor who negotiated with the private school that was going to kick out her kids for being behind on tuition.”

Find your purpose. In short, ask yourself what will give your life new meaning, and go do it!

The below article written by John O. McManus was published in Trust & Estates‘ newsletter “The Estate Planner” and on wealthmanagement.com.

Five Estate Planning Tips that Remain Relevant Regardless of Shifting Political Winds

Add them to your clients’ to-do lists.

By John O. McManus | Jul 18, 2018

There are important estate planning techniques that aren’t directly affected by legislation and changes in tax law, but that can still make a big impact on wealth preservation. From regularly updating a will to consistently moving assets off a balance sheet, here are five estate planning items that should be added to your client’s to-do list.

Ask clients to consider whether the individuals named in their documents are still appropriate. Think about positions including power of attorney (POA), health care agent, guardian for minor children, trustees of an irrevocable or testamentary trust, trust protectors and trustee appointers (if any).

Ask the client questions, such as:

Has the client’s relationship with any of the people named changed?
Has the client’s life situation of any of those named changed?
Has the health of any of those named changed? If a client’s parents were initially named as guardians for minor children, but the parents are now older and in poor health, for example, alternative guardians who can keep up with kids may need to be named instead.
Are all of the people who have been named still geographically appropriate? For example, if a client’s trusted POA moved across the country and can’t now serve in an emergency, a new POA should be named.

Next, clients should also consider whether the beneficiaries named are still proper. Ask the client questions, such as:

Are the amounts left to each beneficiary still appropriate?
Again, how’s the client’s relationship with each beneficiary? For instance, has there been a falling out with any of them?
Are there new beneficiaries (nieces, nephews, charities, etc.) the client now wishes to include? Or have the client’s documents been drafted cover new children and grandchildren automatically?
Are any of the beneficiaries at risk with inheriting assets? Are they the target of a divorce, legal action or the victim of financial strife or addiction, for example?
Finally, think through whether the current trust provisions make best use of the law for asset protection purposes.

“Do it for the Kids”

Set up trusts for your clients’ children and grandchildren.

While the lifetime exemption amount has changed several times in the last decade, the annual gifting exemption has remained fairly constant. Setting up a trust for a client’s children and grandchildren allows him to tap into this reliable wealth transfer mechanism without the damage of gifting assets to them outright. With this strategy:

Assets will be held in a protected vehicle, meaning they can be passed on to the next generation outside of the children’s estates, as well.
A trustee can manage and control the assets while the children are minors.
The client’s spouse should be added as a beneficiary, and the grantor should retain the power to take loans from the trust.

Move Assets off Your Clients’ Balance Sheets

Have the client sell the family business, real estate, life insurance, investment accounts and more into a trust.

A family business is typically a long-term investment, so have the client sell it into a trust. This provides an income stream to older individuals who may wish to surrender the day-to-day operations of the business without losing access to the economic security of the asset. It also puts the asset in a protected vehicle that’s exempt from estate tax.
Have the client sell business interests when the value is modest so that growth takes place outside of his estate. Selling a business interest also allows for valuation discounts, with greater equity going into trust.
Real estate can be sold into trust for a similar purpose as family businesses.
Life insurance can be sold into a trust to avoid the 3-year look-back. If a client gifts life insurance into his irrevocable trust and passes away within three years, the Internal Revenue Service will claw that asset back into his estate. The sale prevents this.

Make the Switch

Swap low basis assets out of your client’s trust.

Assess the income tax benefits of holding assets inside a client’s estate versus the estate tax benefits of pushing them outside of his estate.
With a critical eye, consider swapping estate assets for the trust’s assets, and vice-versa, to maximize the income tax basis step-up.
A step-up in basis is the readjustment of the value of an appreciated asset for tax purposes. With a step-up in basis, the value of the asset is determined to be the higher market value of the asset at the time of transfer, not the value at which the original party purchased the asset.
When an asset is gifted to an individual or trust, there’s a carryover of the original basis – meaning there’s no step-up. Although the asset is now outside the grantor’s estate for estate tax purposes, on the sale of the asset, capital gains tax will be due.
When an asset is included in a descendant’s estate, the asset receives a step-up in basis to the date of death value at that time. The asset can be sold to avoid any capital gains tax.

The opportunity to achieve the step-up is available now and should be seized. It’s highly likely that the strategy will be advantageous to undertake at any time in the near future, with minimal downside risk.

Give Precedence to Giving Back

Use foundations and charitable trusts to make philanthropy a focus for your client’s family and to help him achieve income tax benefits.

Family unity can be created through a consistent emphasis on giving back.
Foundations and charitable trusts also both have income tax benefits. The tax rates may change, but income tax is unlikely to go away, so this will always be an important piece of a good planning strategy.
Donations should be reviewed annually to assess portfolio performance, confirm that the foundation is meeting minimum distributions for charity and verify that the donative patterns are still desirable.

The political ping-pong commonly seen in the U.S. leads to legislative changes that make it necessary to reevaluate one’s tax strategies every few years. However, there are also important estate planning techniques that are not directly affected by legislation and changes in tax law, but that can still make a big impact on wealth preservation. From regularly updating your will to consistently moving assets off your balance sheet, several estate planning items should be added to your to-do list.

Consider whether the individuals named in one’s documents are still appropriate. Think about positions including power of attorney, health care agent, guardian for minor children, trustees of an irrevocable or testamentary trust, trust protectors and trustee appointers (if any). Ask questions, such as:

Has the relationship with any of the people named changed?

Has the life situation of any of those named changed?

Has the health of any of those named changed? If one’s parents were initially named as guardian for minor children, but the parents are now older and in poor health, for example, alternative guardians who can keep up with kids may need to be named instead.

Are all of the people who have been named still geographically appropriate? For example, if one’s trusted power of attorney moved across the country and cannot now serve in an emergency, a new power of attorney should be named.

Next, one should also consider whether the beneficiaries named are still proper. Ask questions, such as:

Are the amounts left to each beneficiary still appropriate?

Again, how is one’s relationship with each beneficiary? For instance, has there been a falling out with any of them?

Are there new beneficiaries (nieces, nephews, charities, etc) one now wishes to include? Normally, documents drafted by McManus & Associates cover new children and grandchildren automatically.

Are any of the beneficiaries at risk with inheriting assets? Are they the target of a divorce, legal action, or the victim of financial strife or addiction, for example?

Finally, think through whether the current trust provisions make best use of the law for asset protection purposes.

2. “Do it for the Kids”: Set up trusts for your children and grandchildren

While the lifetime exemption amount has changed several times in the last decade, the annual gifting exemption has remained fairly constant. Setting up a trust for your children and grandchildren allows one to tap into this reliable wealth transfer mechanism without the damage of gifting assets to them outright. With this strategy:

Assets will be in a protected vehicle, meaning they can be passed on to the next generation outside of the children’s estates, as well.

A trustee can manage and control the assets while the children are minors.

The spouse should be added as a beneficiary, and the grantor should retain the power to take loans from the trust.

3. Move Assets off Your Balance Sheet: Sell the family business, real estate, life insurance, investment accounts and more into a trust

A family business is typically a long-term investment, so sell it into a trust. This provides an income stream to older individuals who may wish to surrender the day-to-day operations of the business without losing access to the economic security of the asset. It also puts the asset in a protected vehicle that is exempt from estate tax.

Sell business interests when the value is modest so that growth takes place outside of one’s estate. Selling a business interest also allows for valuation discounts, with greater equity going into trust.

Real estate can be sold into trust for a similar purpose as family businesses.

Life insurance can be sold into a trust to avoid the three year look-back. If you gift life insurance into your irrevocable trust and pass away within three years, the IRS will claw that asset back into your estate. The sale prevents this.

4. Make the Switch: Swap low basis assets out of your trust

Assess the income tax benefits of holding assets inside one’s estate versus the estate tax benefits of pushing them outside of one’s estate.

With a critical eye, consider swapping estate assets for the trust’s assets, and vice-versa, to maximize the income tax basis step-up.

A step-up in basis is the readjustment of the value of an appreciated asset for tax purposes. With a step-up in basis, the value of the asset is determined to be the higher market value of the asset at the time of transfer, not the value at which the original party purchased the asset.

When an asset is gifted to an individual or trust, there is a carryover of the original basis – meaning there is no step-up. Although the asset is now outside the grantor’s estate for estate tax purposes, upon the sale of the asset, capital gains tax will be due.

When an asset is included in a descendant’s estate, the asset receives a step-up in basis to the date of death value at that time. The asset can be sold to avoid any capital gains tax.

5. Give Precedence to Giving Back: Use foundations and charitable trusts to make philanthropy a focus for your family and to achieve income tax benefits

Family unity can be created through a consistent emphasis on giving back.

Foundations and charitable trusts also both have income tax benefits. The tax rates may change, but income tax is unlikely to go away, so this will always be an important piece of a good planning strategy.

Donations should be reviewed annually to assess portfolio performance, confirm that the foundation is meeting minimum distributions for charity, and verify that the donative patterns are still desirable.

An estate freeze is a power strategy for wealth management. Practitioners must be diligent in utilizing this estate planning tool, however, because even the most basic estate freeze can create a minefield of potentially negative estate, income tax, and family problems.

McManus & Associates Founding Principal John O. McManus was recently an expert speaker for the Lorman Education Services webinar, “Estate Freeze Due Diligence,” during which he outlined practical applications of estate freeze techniques and their benefits (which should be weighed in light of one’s expectations and business, financial, and personal goals). The presentation also provides an understanding of the common implementation challenges and pitfalls that can accompany an estate freeze strategy and, just as important, ways in which those dangers can be avoided and addressed.

See and listen to John’s presentation on the topic by clicking below. For more questions or more detailed guidance, call McManus & Associates at 908-898-0100.

Death represents a significant and vulnerable point in time for both the individual facing it and his or her loved ones. In the medical field, it is even associated with failure; only five out of 125 medical schools (4%) in the country offer a course on death and dying. This negative stigma means that what should be accepted as a natural part of life, often becomes an uncomfortable topic.

However, it is important to talk about death with loved ones. There are emotional benefits to reflecting on a life spent together, and expressing gratitude and admiration. It is also important to ask difficult questions so that this topic receives adequate attention and preparation. While everyone would prefer to focus on life, a significant amount of stress related to death can be reduced by proper planning.

Press play to hear McManus & Associates Founding Principal John O. McManus explain his 10 recommendations below for getting the best end-of-life care:

John O. McManus, Founding Principal of McManus & Associates, was featured as one of New York’s Leading Lawyers in a special section of award-winning New York Magazine. Here’s a picture of the plaque celebrating the special recognition. McManus & Associates congratulates you, John, for being chosen as a “Leader in the Law”!

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